Case Study – Knight Capital Americas LLC

Posted: January 4th, 2023

Case Study – Knight Capital Americas LLC

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Case Study – Knight Capital Americas LLC

Today, nearly all business activities rely on technology. Companies adopt a scenario where every internal process and client interaction relies so much on computer systems that run virtually every aspect. It is the reason why corporations are embracing management information systems (MIS) made up of hardware and software to serve as the backbone of the firm’s activities. Organizations are working hard to advance their MIS now that it is evident the system can collect information from numerous online systems, analyze the data, and report issues to facilitate decision-making. Even as companies strive to install better systems, it is essential to consider the possible constraints that could derail the implementation process most of which may be technology-related. The study shows how the problem at Knight would not occur if the management and the IT staff were conversant with the possible errors that are likely to occur when advancing to superior forms, and were aware of the strategic models that would prevent risks and facilitate change.

Background of the Case

Knight Capital Americas LLC was an American multinational financial institution that engaged in institutional sales, trading, electronic execution, and marketing. The company employed advanced trading systems which made it the largest trader in American equities, with a market share of nearly 17.5% on the New York Stock Exchange and 17% on NASDAQ. Unfortunately, the group experienced significant constraints in 2012 that emanated from technical errors that turned out to be catastrophic. The company’s information technology (IT) staff had installed new software – SMARS, on its servers to facilitate stock trading using computer systems, but seemingly something was not okay. One of the eight servers that ran the software was quite different from the other seven because the faulty server started dispatching trade orders to the market without documenting whether past orders were filled. The error resulted in a scenario where large volumes of buy and sell orders were streamed from the company into the market at very high speed. Knight’s management realized when it was very late after the prices of at least 150 stocks of firms, big and small, started to swing, some climbing, some dropping, many by more than 10% within few minutes. The trade continued for 45 minutes after which the firm noted something was amiss then informed clients to discard the listed orders. The error came as an unexpected incident to a company that had some of the largest and most effective data centers in the sector, and showed that the tens of millions invested everyday to improve the technology platform had gone to waste. The company had to pay a hefty fine to the SEC because of the mishap, which also contained violations of SEC rules and regulations.

Identifying the Problems

The main problem as it appears in the case stems from the technological mishap that rendered one of the servers erroneous yet the company’s IT staff believed it was competent to implement the technology without any difficulty. The confidence held by the IT staff was sparked by a prior test of the new software that showed positive results when only a few servers were used. Unfortunately, the failure to review all systems caused a major lapse when the eighth server could not function properly.

Lack of proper governance might have contributed towards the problem that escalated and left the company seeking for assistance from various quarters. Knight’s CEO (Thomas Joyce) expressed his dissatisfaction and embarrassment about the technology hitches at the firm, and even confessed about his remarks when he criticized NASDAQ for handling Facebook’s Initial Public Offer (IPO) inappropriately due to what it termed as technology blunders. The CEO in his attempts to explain the incident pointed a finger of blame to a group of workers whom he thought were responsible for the grievous fault.

The inadequate governance and oversight during the transition may be attributed to the sparse application of risk management and change management concepts that are usually essential during such scenarios. The entire team seemed to have belittled the possible risks that could occur upon implementation, which denied them the opportunity to come up with alternative remedies or preventive measures that could evade further harm. The team working on the implementation seemed to have forgotten that risk management is a crucial function for organizations that desire to maintain stability and widen at a sustainable speed. The leadership seemed to have forgotten that risk management is a vital guide to ensure that the organization is familiar with all the risks it is likely to experience, and that it is necessary to take suitable measures to mitigate the threats. The improper governance as displayed during the implementation of the new system further casted doubts as to whether the company was competent in its management of change bearing in mind that transformation is the only stable reality of life and is evident in all realms of life. Maybe, the group did not invest in familiarizing its workers with how to manage change, or maybe the whole team disregarded the turnover as being light, and there would be no need to apply so much managerial concepts and guidance. Regrettably, the ineffective risk and change management techniques caused a huge loss that took the company a lot of energy and resources to fight.

The incident, as already hinted, prompted the SEC to levy a fine against the company for violating some of the crucial directives, which insinuates that noncompliance with legal provisions, contributed towards the problem. The SEC imposed a $12 million fine against the financial institution for contravening a number of legislations, including Section 15(c)(3) of the Exchange Act and Rule 15(c) (3) – 5 that follows. The SEC also blamed Knight for violating Rules 200(g) and 203(b) of Regulation SHO. As a result, the institution was penalized for not enacting effective measures in several key areas, such as precautions to prevent such as a catastrophe during trading and directives in the area of testing and deploying codes, as well as no proper guidelines for reacting to an issue when it stars to surface. The SEC, for instance, noted in its report that the company failed to react to the initial warning offered by the Power Peg disabled error emails, which showed some ignorance. The report further highlighted that before mid-2012, the CEO had signed a certification regarding a rule that was ultimately ruled to have been contravened because it did not state that the firm’s procedures and controls adhered to the rule. Instead, the certification only implied that the company had in place controls to adhere to the rule. The inability to comply with vital legislations that could have prevented the occurrence of the incident indicates that the workers needed more familiarization with rules and regulations that define operations in the sector.

Possible Solutions

The series of events at Knight left many people perplexed and asking hard questions. Many wondered how such a technology giant could become a victim of such a severe incident, while many wondered whether something could happen to prevent the occurrence. Knight, however, would be in a good position to deal with the issue if the CEO and his team embraced some measures prior to the incident. The management in this case should have realized that MIS could experience technical breakdowns that could prevent it from conducting its functions effectively, including improving decision-making, offer up-to-date and precise data on key organizational features such as marketing, R&D, inventory, orders and sales, and financials among others. The CEO should have known that whereas advanced technology facilitates operations and gives the firm competitive advantage over others; such systems are highly susceptible to errors, especially when the implementation strategy is ineffective and proper oversight and review lacks. The leader in this case would prevent these errors by taking the IT staff through a series of training that enlighten them about what needs to happen to prevent possible problems. Furthermore, the leaders could advocate for an entire review of the system before using the system to ensure all servers are in good condition to work.

The CEO would evade the error if he and his team applied the concepts of dealing with the risks that may affect business operations. Applying risk management would tell the business about the possible threats it could experience with the application and would allow the IT team to preemptively prevent hazardous effects. Often in the absence of a risk management plan, the business would encounter heavy losses just as it happened to Knight. The company would increase its chances of mitigating the risk if it applied the risk management framework that outlines the actions that need to be carried when dealing with such incidences. Applying risk management would address information system component threats such as unpredicted errors, unprepared staff, and software and hardware failure among others.  

The CEO while using risk management should stick to a definite structure that would lead to the best results. The initial step would be to identify the possible threats that the firm is exposed to in its application of the new software. It would be better if the group considered the risks from a wider perspective, including the environmental risks, the regulatory (legal) risks, and market risks among others as part of identification. The second step would be to analyze the risks and determine their scope should they occur. Analyzing the risks would also entail finding out its seriousness and severity to know how much effect would occur should the threats emerge. The third step would be to evaluate the risk by ranking and prioritizing them in terms of severity or possible effects. The team, for example, would rank possible technology error as highly possible and find out the likely effects and remedies. The company would not have much problem rectifying the problem if it had outlined how it would deal or treat the risk because every threat needs to be eradicated or eliminated as much as possible. The company, for example, could have planned that it would consult particular experts should the risk occur, or outline how it would react very fast to neutralize any adversities. The final step in creating a risk management plan would be to elaborate how the group would monitor and review the risks considering that it might not be easy to eliminate all risks. Knight, in this case, would have assigned some employees to carry out the review process once the system commences work to avoid any errors such as the one that occurred with the server that could not function properly.

Being conversant with some of the change management theories would save the company from undergoing the big loss due to the technology failure. The management should have worked closely with the IT team to identify an appropriate channel of transiting from the old to the new system without any difficulties. Even though the team could borrow from a wide range of change management theories, it would be easier to prevent any fatalities if the professionals adhered to the provisions of Kurt Lewin’s change theory that continues to guide organizations seeking to transit from one situation to another. Lewin’s theory requires the team in charge of change to consider three critical phases associated with the framework. The IT team and the management at Knight while shifting from the old to the new system should have considered the unfreezing stage which entails discovering a way of making possible to overcome old patterns or technology that are not productive in any way. The unfreezing phase would be essential because it would help to overcome the strains that deter progress. The second phase that would guide the team in making successful transition is the changing phase where the real changeover happens. Everything needs to happen perfectly at this stage to avoid hitches such as the ones at Knight. It even appears that the firm lacked a formal SWAT-team guideline so when the issue commenced, the IT personnel panicked trying to figure out the cause of the issue, while the defective program continued to dispatch millions of orders. The implementers should not have disregard any feature or make conclusions that all components would work well without ensuring that the system is free from all features of the Power Peg code. Applying the third phase of Lewin’s structure (refreezing) would allow the IT staff and the entire workforce to be familiar with the new structure because failure to focus on this area could increase the likelihood of going back to the olden days.

The leadership should consider other factors that could help to prevent fatal technological errors. Assigning a special team to be in charge of the risk and change management would allow for the application of suitable strategies in handling the case, and would ensure that each process takes place without skipping essential aspects. The team in charge of risk management will adhere to the five steps outlined above, as well as follow the change management theories that give adequate insight. Certainly, applying risk and change management techniques would prevent Knight from experiencing the loss it encountered.

The CEO would also prevent the incident if he ensured each person working on the project is conversant with the key legislations that define such implementations. It is suitable to encourage all workers to familiarize themselves with the rules and regulations that guide their operations to avoid such incidences that have severe effects on the organizational activities. The leaders too, should dedicate much time and energy towards understanding the regulations to guide the employees towards the right direction when it comes to adhering to the set directives. It would be easier for the organization to follow the said rules and regulations if tall the workers were familiar with them through vigorous training and early sensitization.

Applicability

The case offers fundamental lessons to corporations that are unable to manage risk, particularly the large modern companies that operate in the increasingly complex and fast-moving global markets. The incident and its effects inform other operators to always be keen when implementing a MIS or other technological innovations that are aimed at advancing or hastening business operations. Other firms learn that being keen when using technology is crucial to avoid the possible technical hiccups that could later cause inconveniencies. The evaluation further informs about the importance of employing suitable governance structures when seeking to change business operations should consider applying risk and change management frameworks that would lead towards the adoption of the right decisions and approaches. Other groups while seeking to mitigate risks should not forget to identify, analyze, evaluate or rank, treat, and review the risks. The study informs on the value of not overseeing or ignoring some things that may appear to be unnecessary yet that may cause severe effects. Otherwise, disregarding the lessons from the case study could cause a scenario where other companies become victims of such faults that would always cause severe losses as it happened to Knight.

Conclusion

The evaluation illustrates how Knight failed to successfully implement new software due to various problems that only came into the limelight after it was too late to put any preventive measures. The company, being of the leading in terms of technology use in its sector, assumed that it would implement the new software without any hitches as it has done over the years. Unfortunately, Knight’s failure to consider the possible technological risks that could arise from the application caused the failure of one server that sent wrong signals to various operators. The IT staff believed it was competent enough to roll out the new RLP code, and that the initial successful test was enough to confirm everything was okay. Other than the technical miscalculation that was the primary root of the problem, the leadership failed to display adequate focus on the implementation, which deprived the process of valuable insight that would manage risk and change. It also emerge that failure to comply with key rules and regulations contributed towards the hitch that caused severe loss and immense tension. The group would not experience the situation if the CEO was conversant with the possible technology defects that come with using MIS and if he knew how strategic approaches aimed at managing risk and change would help evade the problem.